2.4 National Income

Question 1

What does the most basic form of the circular flow of income consist of ?

Answer 1

Two sectors ; households and sellers / producers.

Question 2

What is the circular flow of income ?

Answer 2

A simplified representation of the floe of Money, goods and services between households and firms in an economy.

Question 3

What do households supply firms / businesses with and what do they get in return ?

Answer 3

They produce labour and in return get wages / salaries.

Question 4

What are the three ways of measuring economic performance ?

Answer 4

National Output
National expenditure
National Income

Question 5

What is national income ?

Answer 5

Income paid by firms to households on goods and services in return for land, labour, capital and enterprise.

Question 6

What is national expenditure ?

Answer 6

The value of spending by households on goods and services.

Question 7

What is national output ?

Answer 7

The value of goods and services from firms to households.

Question 8

Why do all the three ways of measuring the level of economic activity come to the same answer ?

Answer 8

National output = National income = National expenditure

Question 9

Why is the two sector model of the circular flow of the economy too simplified ?

Answer 9

• The government needs to be added as they take money away through taxation and add money by spending.
• The model needs financial services who can inject money into the system through investment and take money from consumers ( thier savings ).
• foreign markets need to be added due to exporting and importing.

Question 10

What is the difference between income and wealth ?

Answer 10

Wealth is a stock of assets whilst income is a flow.

Question 11

What is wealth ?

Answer 11

Things that people own : houses, possessions etc

Question 12

What is income ?

Answer 12

The money people receive : money from work, interest from savings etc.

Question 13

What are the three injections in the economy ?

Answer 13

Government spending
Investment
Exports

Question 14

What are three withdrawals / leakages in the economy ?

Answer 14

Taxes
Savings
Imports

Question 15

What occurs when injections are greater than withdrawals ?

Answer 15

The economy is growing

Question 16

What occurs when withdrawals are greater than injections ?

Answer 16

The economy is shrinking.

Question 17

What happens when the economy is in equilibrium ( in terms of withdrawals and injections ) ?

Answer 17

Injections = withdrawals
So national income stays the same.

Question 18

Where is equilibrium position for national income on a diagram ?

Answer 18

Where AD and AS meet.

Question 19

In the short term, what do both classical and Keynesian economists agree on ?

Answer 19

That AD will be downward sloping and AS will be upwards sloping.

Question 20

What shape is the classical LRAS curve ?

Answer 20

Perfectly inelastic

Question 21

What is meant by the classical LRAS curve being perfectly inelastic ?

Answer 21

A change in price has no effect on change in output. ( a shift in Ad would not affect long run national output and will only affect price levels ).

Question 22

What do classical economists believe in the long term about employment ?

Answer 22

The economy will always return to full employment level and therefore there will be no unemployment in the long run.

Question 23

How do classical economist believe an economy can increase output ?

Answer 23

Increasing ( shifting ) LRAS - AD changes without this only cause inflationary pressures.

Question 24

Why do Keynesian economists believe that there can be equilibrium at less than full employment ?

Answer 24

They don’t believe that a rise in unemployment rapidly leads to a fall in real wages.

Question 25

On a Keynesian LRAS, what does the impact of the shift depend on ?

Answer 25

the elasticity of the curve ( whether the economy is at full capacity or not ( elastic part ) ).

Question 26

What is the multiplier process ?

Answer 26

The idea that an increase in AD because of an increased injection can lead to a further increase in national income.

Question 27

What is the size of the multiplier determined by ?

Answer 27

How much of an increase in income people’s will spend : the marginal propensity to consume. Lower leakages, high MPC, the bigger the multiplier.

Question 28

What concept / model does the multiplier work upon ?

Answer 28

The circular flow of income : one man’s spending is another’s income.

Question 29

What is a negative multiplier effect ?

Answer 29

When a withdrawal from the economy could lead to an even further fall in income, decreasing economic growth and possibly leading to a decline in the economy.

Question 30

What can governments do to maximise the multiplier effect of thier initial injection ?

Answer 30

Target those with the biggest Marginal propensity to consume.

Question 31

What are drawbacks about the multiplier effect ?

Answer 31

• It is impossible for the government to know the exact effect.
• There can be a time lag between the increase in income and the effect of that increase as not everyone will spend this straight away.

Question 32

In terms of curves, what will the size of the multiplier effect depend on ?

Answer 32

The change in AD ( affected by income ) and elasticity of the AS curve.

Question 33

What is meant by MPC ?

Answer 33

The increase in consumption following an increase in income.

Question 34

What is meant by MPS ?

Answer 34

The increase in savings following an increase in income.

Question 35

What is meant by MPT ?

Answer 35

The increase in taxation following an increase in income.

Question 36

What is meant by MPM ?

Answer 36

The increase in imports following an increase in income.

Question 37

What is meant by MPW ?

Answer 37

The increase in leakages following an increase in income.

Question 38

How do you calculate the marginal propensity to withdraw ?

Answer 38

MPW = MPS + MPT + MPM

Question 39

How do you calculate the multiplier effect ?

Answer 39

Multiplier = 1 / ( 1 - MPC )

Question 40

What is the only impact that the multiplier effect will have on classical LRAS ?

Answer 40

Only an increase in price, as classical economists don’t believe there is spare capacity in the economy.